How to Protect Your Gold ETF the Smart Way

By Brendan Conway

Societe Generale’s strategists, well-known gold bears, said recently they expect a gold price of $1,200 this year, and as low as $1,150 next year.

Thus it’s no surprise that a group who expects gold to fall another 13% from Wednesday’s price recommend investors take a defensive posture on their gold holdings — in this case an options trade on the SPDR Gold Trust (GLD).

But the idea backed this week by SocGen’s James Hosker isn’t just to take a bearish position on the price of gold. It’s to take advantage of the very negative climate of investor opinion, which has sent the price of defensive gold options soaring the last few months.

The red line in this chart shows you the “skew” of SPDR Gold Trust options, which you can read as a kind of worry premium. Note how the line has soared this year.

When the skew rises, it gets more costly to take a defensive or bearish position. But the fact that investors can also sell these options, including by taking the 1-by-2 put spread position SocGen recommends, offers one way to reduce the cost.

The firm specifically advises selling two times as many deep out-of-the-money puts as the number of at-the-money option you’re buying. It’s a way of using the market’s inflated worry premium to your advantage.

Note, however, that this doubling up on the low end adds the risk of outsized losses in the event that the ETF cascades through the firm’s low target of $115 (or $1,150 per ounce, if your measure is the metal’s price).

Still, it looks like a good bet if you’re worried about further price declines, but not an outright crash.

About Focus on Funds

As exchange-traded funds and other investing vehicles have ballooned in number, the task of figuring out what works well and what doesn’t has only gotten harder. Barrons.com’s Focus on Funds looks under the hood of ETFs, mutual funds and hedge funds for overlooked values, actionable ideas and the latest pitfalls for fund investors.